Archive for December, 2011

Stock Market Appreciation – I Am Going To Be Rich!

December 11, 2011 Leave a comment

In my last blog, I discussed the three reasons that people own stocks.  We looked at the first reason which was in order to receive a stream of income in terms of a dividend.  This alone certainly did not make a lot of sense since it was less than half of what you could make with bonds.  Another reason for holding stock was to take over a company and direct it.  I don’t think many of us our in the market for that reason.  That leaves the last one which is we are in the market because we hope to buy and sell our stocks we own for a profit.

In a lot of articles you read about the stock market as an investment they talk about how you need to own stocks because of it’s annualized rate of return.  The number is usually somewhere between 7 – 10% depending on what years they choose to do this for.  Over the last 100 years it has been 9.53%.  The last 50 years it has been not much different at 9.56%.  The last 25 years it was been an outstanding 10.8%.  So, it looks like you better get started investing and getting rich!  Let’s look at the last decade or so to make sure.  The return since 2000 was -30%.

So, what does this mean?  It means that stocks really aren’t something you get a true annualized rate of return like a bond or savings account.  It means sometimes it goes up and sometimes it goes down.  Again, the stock market is an auction and people primarily must buy stocks because they want to sell them for more than they bought them for.  So, in the last 10 years has something fundamentally changed?  Are the companies the stock is for not as valuable as they were 10 years ago?

As you saw in the last blog dividend yields were even lower 10 years ago than they are today, so from the point of view that a stock is only worth the future income it may generate then they shouldn’t be worth any less than they were 10 years ago.  Discounting the dividend growth in terms of a rate of return is only part of the story.  You really need to look at the earnings of a company.  In general, a company makes money (hopefully) and then determines to either reinvest the earnings or pay them out as dividends.  Theoretically, reinvesting earnings will result in more earnings which could be paid out in the fashion of future dividends.  So, how have earnings been doing and how do the correlate with the stock market going up or down?  The equivalent to Dividend Yield (total dividends / stock price) for earnings is the Price to Earnings Ratio.

Since the Price to Earning Ratio was bout 21 that means that the rate of return in terms of earnings is 100/21 or about 5% which puts on par with Bond Yields.  So, the dividend yield as a drive from the last blog could be amended to be the “Earnings Yield” for an investor.  So, why is the market so choppy?  We earlier discussed that dividends did not seem to vary much, but, stock price did.  What about earnings?  Well it turns out that earnings do change over time.  Most companies will try and protect their dividends, but, earnings come and go depending on both the performance of the company, as well as, the state of the overall economy.  As you can see a couple of big peaks set expectations so high that they couldn’t possibly be met and ended in huge adjustments meaning falling markets.

If you look at the economy as a whole, Gross Domestic Product is a measure of how well it is doing.  The higher the GDP the higher the potential is for earnings.  So, in recessions earnings drop.  When earnings drop stock prices normally follow as companies can’t pare down expenses as fast as demand is dropping.  Over the last 10 years GDP has been growing, but, slower than normal (1.75%).   So a classical way of looking at this is that a company is worth the normal earnings it has plus the anticipated growth.  Using GDP as a proxy for growth rate for all stocks then you could say that the average stock is worth the normal earnings (5%) + a forecast for GDP (say 2%).  This would mean maybe somewhere around 7% which is a little lower than it has historically been.  So, the stock market growth should have been 7% minus the dividend yield of 2% or about 5% per year over the last decade.  So, the pure financial reasons for owning stock don’t explain the “lost decade” of growth.

So, if the math doesn’t drive the stock market what does?  I will speculate on that in the next blog.

Categories: Stocks

The Stock Market is Going to Go Up

December 10, 2011 Leave a comment

The Stock Market is definitely going to be going up.  Unfortunately, the Stock Market is also definitely going to be going down.  In the previous blogs, I have been characterizing who owns Stocks and Bonds and how often they get bought and sold.  The next few blogs are going to delve into what makes the prices go up and down.  The most important thing to take away is that they will go up and they will go down.  We will look first at the Stock Market.

As was discussed in earlier blogs, you have to start by taking a look at just exactly what the Stock Market it is before looking at the movement of prices up and down.  Stocks are ownership in a company and as such have some value.  People buy stocks for one of three reasons:

  • Anticipation of getting income in the form of a future stream of dividends
  • The hope of being able to sell the stock later to someone else for a profit
  • The ability to control a corporation and direct what they do

So, which of these factors drive prices up and down.  The assumption is that all three drive it to some degree.  Can we test how much each of these motivations actually determine the price of a stock and whether it will go up and down?  Probably not, but, we will make an attempt anyway.

The dividends would be a good place to start.  The average dividend yield of the S&P 500 is 2.06%.  In the S&P 500 about 25% of the stocks offer no dividends and 75% do.  The 2.06% is all the dividends divided by all the stocks regardless if they paid dividends or not.  If you just look at the stocks paying dividends then the average dividend yield is 2.60%.  In any case, 2.6% does not look like a great return even in today’s paltry interest rates.  The following chart shows high quality bond yields versus the S&P 500 dividend yield.

As you can see, over the last 40 years or so bond yields are consistently at least twice as high as stock dividends.  Normally, bonds are less risky for a number of reasons including that if a company hits bad times a bond holder will get paid before a shareholder.  The other thing to notice is that both bond yields and stock dividend yields have been in a consistent down trend over the last 30 years.  The first thought is that this must be due to inflation.  Bond rates are not specifically tied to the inflation rate although with the role of the Federal Reserve Bank to control inflation, it is common policy for the Fed to raise the prime lending rate in order to “cool off” an economy and help control inflation.  A bond is tied to this prime lending rate and not directly to inflation.

Also notice the spikes associated with dividend yields.  There were huge spikes in 1929, 1982, 2008, etc.  These spikes were associated with the depression and some pretty big recessions.  So, does this mean that companies start paying out higher and higher dividends in order to lure people back into the stock market.  Unfortunately, that was not the case, it was the fact that the denominator (the total capitalization of the stock market) was lower that caused the dividend yield to spike and not the case of the numerator (dollars paid as dividends) that got higher.

So, the best that can be said for a person to hold stocks for the dividends is that you will earn half of what you could earn with bonds.  That means that people must hold stocks for the other two reasons (stock appreciation or wanting to own a company).  Let’s assume that individual investors don’t often try and own a company (Warren Buffet types not included).  Then the average investor is in the Market because they think that people will pay them more for their stocks than what they bought them for.

My next blog will go into why people would pay more for stocks than the future stream of dividends.  On the surface, it just doesn’t make any sense.  It seems like the worse kind of Ponzi scheme or is it just simple economics at work?

Categories: Stocks

Who really owns bonds?

December 4, 2011 Leave a comment

This blog will try to characterize who owns bonds.  As identified in my last blog, the Total Corporate and Foreign Bond market as identified in the Federal Reserve Flow of Funds documents is $11.3 Trillion dollars.  It is mostly made up of traditional Corporate Bonds, Asset Backed Securities and Bonds issued by Commercial Banks or Bank Holding Companies.  The following chart shows who owns this $11.3 Trillion Dollars in Bonds:

The number one owner somewhat to my surprise isn’t Americans at all it, but is Foreign Investors.  This is followed by Insurance Companies.  Ownership of bonds by families is next either by owning individual bonds or through mutual funds (both at 15%).  So, the average family owns about 30% of the bond market.  For are mythical average American Family this would be about   $11.3 Trillion Total Bond Market * 30% Owned by Individuals / 95.6 Million Families = $36,000.  This $36.000 per Family would be evenly divided between individual bonds they owned ($18,000) and bond funds they had invested in ($18,000).

As we saw in earlier postings, you need to dig a little deeper to find out really what the average family owns.  For example, looking at the difference between average (mean) and median ownership.  Also, looking at the wealth of the people owning the bonds and their age would be interesting to know just like we did for stocks.  Digging back into the Survey  of Consumer Finances (SCF) Study by the Federal Reserve we can get a little bit of a deeper insight into who really owns bonds.  The first surprise is how few people actually hold bonds for how big the market is.  Direct bond ownership has been decreasing dramatically over the last few years as evidenced by the following chart:

So, if only about 1.5% of families actually own bonds directly and that means the average value of the bonds a family holding bonds would be $18,000 Direct Bond Ownership per all families / 1.5% families owning bonds = $1.2 Million.  In other words the average direct holder of bonds isn’t your average Joe or Jane, it is someone with a lot of money.  It looks like bond ownership is highly concentrated with the wealthy from this chart.  Looking into more statistics from the SCF Study they show the median value of families owning bonds to be much less than the mean or average ownership of about $1.2 Million.  Even though it is much less than the average (mean), it has been growing.  Again, this points out to concentration towards the higher end of the wealth bands.  The median was about $80,000 and growing in 2007.  It would be interesting to see what it is now, but, we must wait on the next SCF study released in 2012 for that.

As you would expect total bond holding is concentrated with the wealthiest 10% of families with the them holding over 50% of the total bond market in terms of value.  This is a little lower than the 60%+ they own of the stock market.  In terms of age, as you would expect, the older we get the more bonds we tend to own versus stocks with over 95% of bonds owned by people over 50.  That would make sense as a bond can provide income if you are retired and is considered to be less risky than stock market investing for those not willing to risk as much of their portfolio as they get near retirement.  We will look at the relative risk of stock versus bond ownership in a future blog.

In summary, bonds are not nearly as widely owned as stocks with only 1.5% of families owning bonds versus around 18% owning stocks.  Using medians as are measure of the individual typical investor, if you do own bonds you own about $80,000 worth of bonds versus the $107,000 worth of stock.  The SCF does not give us insight to the bond funds we own, but, I would hazard a guess that they are much more liberally sprinkled across stock ownership.  Remember the pooled investments (i.e. mutual funds and bond funds) were owned by about 12% of families.  The median value of these pooled funds per family was about $55,000 per year and has been consistently growing.  This means that a lot of families are not choosing to invest in individual stocks and bonds, but, instead are becoming “pooled” or fund investors.  Part of this is the growth of Exchange Traded Funds, as well as, traditional Mutual Funds.  While bonds are an important part of our economy not many people are directly invested in them.

Categories: Bonds, Uncategorized